TIMMERTON COMPANY INC v. EQUITY TRUSTEE LTD AND ANOTHER

CACV53/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 53 OF 2014

(ON APPEAL FROM HCA 2167 OF 2012)

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BETWEEN

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JUDGMENT

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Hon Lam VP:

1.  I agree with the judgment of Hon. Chu JA and for the reasons given by her, there shall be an order as per paragraph 29 below.

Hon Chu JA:

Introduction

2.  This is the defendants’ appeal against the decision of Mimmie Chan J (“the Judge”) given on 11 February 2014 dismissing their application to set aside the order of Master K Lo dated 28 January 2013 giving leave to the plaintiff to issue and serve on the defendants out of jurisdiction a concurrent amended writ of summons.  Leave to appeal was granted by the Judge.

3.  The core issue in this appeal is whether the defendants are trustees within the meaning of section 20(1)(b) of the Limitation Ordinance, Cap. 347, which in turn will determine whether the plaintiff’s claim against the defendants are time-barred under section 20(2) of the Ordinance.  

Background

4.  The background to the plaintiff’s claim is set out in the statement of claim at §§1-26. For the purpose of this appeal, it is only necessary to highlight the following:

(1) The plaintiff is a company incorporated in Liberia. The late Dr Mong Man Wai, William (“Dr Mong”) and his former wife, Madam Yang, were its first directors.

(2) Both defendants are companies incorporated in the British Virgin Islands.

(3) The 1^st defendant is the trustee of Huge Surplus Trust (“the Trust”), a discretionary trust created by a trust deed dated 20 November 1989.  The children of Dr Mong and Madam Yang together with Madam Yang are the Specified Beneficiaries of the Trust.

(4) The shares in the 2^nd defendant are beneficially owned by the 1^st defendant through Turquandia Limited, a Hong Kong company, and are assets of the Trust.

(5) Harmony William & Family (Holdings) Limited is a Hong Kong company. In 1993, it changed its name to Shun Hing Holdings Company Limited (“SHH”).  Dr Mong and Madam Yang were the company’s first shareholders and first directors.

(6) As at the end of 1980, the shareholding in SHH consisted of 100,000 shares, of which 99,800 were held by the plaintiff, 100 were held by Dr Mong and another 100 held by Madam Yang. Dr Mong and Madam Yang had each executed declaration of trust in respect of their respective shareholdings in SHH in favour of the plaintiff.

(7) In or about June 1981, SHH resolved to increase its share capital by 100,000 new shares.  In or about late 1989 or by 8 January 1990, these shares were issued to the 2^nd defendant at the par value of $100 each.  Consequently, the plaintiff and the 2^nd defendant each holds 50% of SHH.

(8) In June 2001, the shareholders of SHH resolved to increase its capital by the creation of 800,000 new shares of $100 each, and approved the allotment of 400,000 shares to each of the plaintiff and the 2^nd defendant.

(9) The 2^nd defendant subscribed for its 400,000 shares through a set-off with SHH of a balance owing to it from SHH from dividends declared, but not paid. 

The plaintiff’s claim

5.  The crux of the plaintiff’s complaint as appeared by the statement of clam (§§27 to 30 and 38) is that:

(1) The allotment of 100,000 shares to the 2^nd defendant in late 1989 or January 1990 was a dilution of the plaintiff’s interest in SHH;

(2) The dilution was for no value in that the source of the funds which the 2^nd defendant used to subscribe the shares was the respective dividends declared by SHH and the plaintiff (represented by three promissory notes issued by SHH) and no monies actually changed hands between the parties. Through several assignments, the three promissory notes were returned to SHH upon the allotment of shares to the 2^nd defendant;

(3) Alternatively, the 2^nd defendant acquired the 100,000 shares at a substantial undervalue to the true value of SHH at the time; and

(4) Since the end defendant had no entitlement to any dividend from SHH, the payment for the allotment of 400,000 shares in 2001 could only be made out of assets impressed with trust for the plaintiff and to which the plaintiff was and is entitled.

6.  It is the plaintiff’s case that the dilution of its interest in SHH for no value or alternatively at a substantial undervalue was procured by Dr Mong in breach of his fiduciary duties to the plaintiff (statement of claim §§31 and 32).

7.  The basis of the plaintiff’s claim against the defendants as pleaded in the statement of claim (at §§ 33 and 34) is that:

“33. [The 2^nd defendant] acquired [the plaintiff’s] interest in SHH with the knowledge that it did so for no value or alternatively at a substantial undervalue. [the 1st defendant], having procured through Ernst & Whinney the transfer of [the plaintiff’s] interest in SHH to [the 2^nd defendant] (the shares in which are, through Turquandia, an asset of the Trust) knew or ought to have known that the transfer was made in breach of Dr Mong’s fiduciary duties to [the plaintiff].

34. In the premises,

(1) [The 2^nd defendant] holds its purported interest in SHH on constructive trust for [the plaintiff] absolutely. [the 2^nd defendant] is, and has been since the purported date of transfer to such interest to it, in breach of trust in failing to restore such interest to [the plaintiff].

(2) [The 1^st defendant] holds its purported interest in Turquandia and through it in [the 2^nd defendant] on constructive trust for [the plaintiff] absolutely and is under a duty to procure that [the 2^nd defendant] satisfies its pleaded obligations to [the plaintiff]. [The 1^st defendant] is, and has been since the purported date of transfer to [the 2^nd defendant] of such interest in SHH, in breach of trust in failing to procure that [the 2^nd defendant] restore such interest to [the plaintiff].”

8.  By way of relief, the plaintiff claims: (i) a declaration that the 2^nd defendant holds its shareholding in SHH together with the profits derived therefrom on constructive trust for the plaintiff; (ii) a declaration that the 1^st or 2^nd defendant holds assets derived from SHH or the plaintiff together with the profits therefrom on constructive trust for the plaintiff; (iii) an order for delivery up to the plaintiff of the 2^nd defendant’s entire shareholding in SHH and all other assets derived from SHH or the plaintiff, together with any profits derived therefrom; (iv) equitable compensation for breach of trust; and (v) injunctions restraining the disposal of the 2^nd defendant’s shareholding in SHH or other assets derived from SHH or the plaintiff.

The issue

9.  Under section 20(2) of the Limitation Ordinance, “an action by a beneficiary to recover trust property or in respect of any breach of trust, not being an action for which a period of limitation is prescribed by any other provision of this Ordinance, shall not be brought after the expiration of 6 years from the date on which the right of action accrued”.

10.  It is common ground that the plaintiff’s claim will be caught by section 20(2) and is time-barred unless it comes within section 20(1), which reads:

“No period of limitation prescribed by this Ordinance shall apply to an action by a beneficiary under a trust, being an action-

(a) in respect of any fraud or fraudulent breach of trust to which the trustee was a party or privy; or

(b) to recover from the trustee trust property or the proceeds thereof in the possession of the trustee, or previously received by the trustee and converted to his use.”  

11.  Section 2 of the Limitation Ordinance provides that the terms “trust’ and “trustee” shall have the same meaning as in the Trustee Ordinance, Cap. 29.  Section 2 of the Trustee Ordinance provides that the terms “trust” and “trustee” extend to implied and constructive trusts.

12.  Since the plaintiff does not allege fraud or fraudulent breach of trust, section 20(1)(a) is not engaged.  The question both before the Judge and in this appeal is whether the plaintiff’s claim comes within section 20(1)(b).  This in turn entails, firstly, the construction of section 20(1)(b) and, secondly, ascertaining what kind of constructive trust or trustee is alleged against the defendants.

The Judge’s decision

13.  The Judge’s reasons for refusing the defendants’ application are encapsulated in §§4 and 5 of the Decision as follows:

“4. On a careful reading  of the Court of Final Appeal judgment in Peconic Industrial Development Ltd v Lau Kwok Fai (2009) 12 HKCFAR 139, it is seriously arguable that in a case such as the present, where the 1^st defendant as trustee under the Huge Surplus Trust had received trust assets from the late Mr Mong and had been holding the assets under a trust, it can properly be called a “fiduciary” in the sense referred to by Lord Hoffman, and can be treated in the same way as an express trustee, such that the limitation period defence is not available to it.   

5. Bearing in mind what eminent judges have as recently as in Williams v Central Bank of Nigeria [2012] 3 All ER 579 referred to as “the uncertainty that appears to attend this sphere of the law” concerning the proper construction of section 21 of the Limitation Act 1980 and section 20 of our Limitation Ordinance, it would not be appropriate in my judgment to set aside the order for service of the writ on the defendants on the basis that there is no serious issue to be tried.  Much will depend on the evidence and the facts showing the role of the defendants, and these are not available at this stage for a full consideration of the matter by the court.  It suffices to say at this stage that there is a serious question to be tried on the plaintiff’s case against the defendants as constructive trustees, on the basis of the defendants’ knowing receipt and handling of trust property.”

Construction of section 20(1)(b) Limitation Ordinance

14.  Mr Joffe who appeared for the defendants submitted that section 20(1) of the Limitation Ordinance does not extend to constructive trusts arising out of knowing assistance or receipt of trust property.  Mr Hunsworth who appeared for the plaintiff indicated in his submission that he had no disagreement to the legal propositions on the construction of section 20(1) advanced by Mr Joffe.  However, for the purpose of the analysis of the plaintiff’s claim against the defendants in the latter part of this judgment, it is necessary to set out the relevant principles and cases.

15.  In Paragon Finance v. D B Thakerer & Co [1999] 1 All ER 400, at 408j-409a, Millett LJ differentiated between two categories of constructive trust and constructive trustee.  The first refers to someone who although not appointed as trustee, has assumed the duties by a lawful transaction which is independent of and preceded the breach of trust and is not impeached by the plaintiff. The second is where the trust obligations arise as a direct consequence of the unlawful transaction impeached by the plaintiff.

16.  The differences between the two categories are that (at 409b to 409g):

“In the first class of case, however, the constructive trustee really is a trustee. He does not receive the trust property in his own right but by a transaction by which both parties intend to create a trust from the outset and which is not impugned by the plaintiff. His possession of the property is coloured from the first by the trust and confidence by means of which he obtained it, and his subsequent appropriation of the property to his own use is a breach of that trust. … In these cases the plaintiff does not impugn the transaction by which the defendant obtained control of the property. He alleges that the circumstances in which the defendant obtained control make it unconscionable for him thereafter to assert a beneficial interest in the property.

The second class of case is different. It arises when the defendant is implicated in a fraud. Equity has always given relief against fraud by making any person sufficiently implicated in the fraud accountable in equity. In such a case he is traditionally though I think unfortunately described as a constructive trustee and said to be “liable to account as constructive trustee.” Such a person is not in fact a trustee at all, even though he may be liable to account as if he were. He never assumes the position of a trustee, and if he receives the trust property at all it is adversely to the plaintiff by an unlawful transaction which is impugned by the plaintiff. In such a case the expressions “constructive trust” and “constructive trustee” are misleading, for there is no trust and usually no possibility of a proprietary remedy; they are “nothing more than a formula for equitable relief”: Selangor United Rubber Estates Ltd. v Cradock [1968] 1 WLR 1555 at p. 1582 per Ungoed-Thomas J.”

17.  The distinction between the two categories of constructive trust is important to the application of limitation.  The first category of constructive trusts is treated as express trusts and claims against the trustee are not barred by the passage of time.  The second category, however, are not real trusts but merely a remedial mechanism for giving relief in equity. Claims for breach of this category of constructive trusts are subject to limitation period (at 409j to 410a).

18.  The above reasoning was applied by our Court of Final Appeal in Peconic Industrial Development Ltd v. Lau Kwok Fai (2009) 12 HKCFAR 139.  The issue before the Court of Final Appeal is whether a defendant having dishonestly assisted in a fraudulent breach of trust is within the section 20(1) of the Limitation Ordinance.  The Court held that dishonest assisters are not fiduciaries and do not come within section 20(1).  Lord Hoffmann NPJ, delivering the main judgment of the court, said (at §19) that for the purposes of limitation, there are two kinds of constructive trustees:   

“First, there are persons who, without any express trust, have assumed fiduciary obligations in relation to the trust property; for example as purchaser on behalf of another, trustee de son tort, company director or agent holding the property for a trustee. I shall call them fiduciaries. They are treated in the same way as express trustees and no limitation period applies to their fraudulent breaches of trust. Then there are strangers to the trust who have not assumed any prior fiduciary liability but make themselves liable by dishonest acts of interference. I shall call them non-fiduciaries. They are also called constructive trustees but this, as Ungoed-Thomas J said in Selangor United Rubber Estates Ltd v. Cradock (No. 3)[1968] 1 WLR 1555, 1582 is a fiction: “nothing more than a formula for equitable relief”. They are not constructive trustees within the meaning of the law of limitation.”

19.  In New China Hong Kong Group Ltd v. Ng Kwai Kai Kenneth [2011] 5 HKLRD 216 at §39, the Court of Appeal held that constructive trustee based on knowing receipt falls within the second type of trustee explained by Lord Hoffmann NPJ in Peconic Industrial Development Ltd, and is not a constructive trustee within the meaning of the laws of limitation.  

20.  In the present case, the Judge when refusing the defendants’ application took the view that there was uncertainty concerning the construction of section 20(1), relying on the English Court of Appeal’s judgment in Williams v. Central Bank of Nigeria [2012] 3 All ER 579 (see §5 of the Decision quoted in paragraph 13 above).  Shortly after the Judge’s Decision, the Supreme Court by a majority reversed the decision of the Court of Appeal, holding that a party guilty of knowing receipt was not a trustee within the meaning of section 21(1) of the Limitation Act 1980[1]: [2014] 2 All ER 489.  Lord Sumption SCJ, with whom Lord Neuberger PSC, Lord Clarke and Lord Hughes SCJJ agreed, explained that (at §31):

“The essence of a liability to account on the footing of knowing receipt is that the defendant has accepted trust assets knowing that they were transferred to him in breach of trust and that he had no right to receive them. His possession is therefore at all times wrongful and adverse to the rights of both the true trustees and the beneficiaries. No trust has been reposed in him. He does not have the powers or duties of a trustee, for example with regard to investment or management. His sole obligation of any practical significance is to restore the assets immediately. It is true that he may be accountable for any profit that would have been made or any loss that would have been avoided if the assets had remained in the hands of the true trustees and been dealt with according to the trust. There may also, in some circumstances, be a proprietary claim. But all this is simply the measure of the remedy. It does not make him a trustee or bring him within the provisions of the Limitation Act relating to trustees.”

21.  In the light of these authorities, it is clear that section 20(1)(b) has no application to constructive trusts and trustees arising out of knowing receipt of trust property or knowing assistance of breach of trust.  

The nature of the plaintiff’s claim

22.  Mr Hunsworth rightly accepted that if at trial the defendants were found to be constructive trustees on the basis of knowing receipt, the plaintiff’s claim would be time-barred.  He also accepted that this would be the case even if the plaintiff has a proprietary claim against the defendants.  He however resisted the appeal on the basis that it is arguable that the defendants are constructive trustees of the first category.   

23.  In advancing this argument, Mr Hunsworth referred to the series of transactions leading to the allotment of 100,000 shares in SHH to the 2^nd defendant pleaded in the statement of claim at §§ 28 & 29.  Specifically, he relied on the fact that the 2^nd defendant had, arguably without authorisation, received assets of the plaintiff, namely, dividends from SHH and dividends issued by the plaintiff (in the form of the three promissory notes) for no consideration and used them to acquire the shares in SHH.  It is submitted that the 2^nd defendant had thereby become a de facto trustee either for the beneficiaries of the Trust or for the plaintiff, a matter which is presently unclear and needs to be clarified through cross-examinations at trial.

24.  There are a number of fundamental difficulties about this argument.  The first hurdle is the plaintiff’s pleaded case.  The statement of claim at §§33 and 34 (see paragraph 7 above) clearly puts the plaintiff’s claim against the defendants on the basis that the defendants are knowing recipients of the plaintiff’s interest in SHH and have consequently been holding the plaintiff’s interest in SHH as constructive trustees for the plaintiff.  The case of de facto trustee or constructive trustee in the first category that Mr Hunsworth sought to advance in his submission represents a major shift from the pleaded case and is simply not borne out by the pleading.

25.  Secondly, as explained by Lord Sumption SCJ in Williams v. Central Bank of Nigeria, supra, 495 at §9, de facto trustees refer to persons who have lawfully assumed fiduciary obligations in relation to trust property, but without a formal appointment. They intend to act as trustees and they are true trustees, and if the assets are not applied in accordance with the trust, equity will enforce the obligations that they have assumed by virtue of their status exactly as if they had been appointed by deed.  An important distinction between the two categories is that trustees in the first category are fiduciaries and are liable as true trustees whereas trustees in the second category are strangers and incur liability by reason of their participation in the transaction which the claimant seeks to impeach.  On the matters identified by Mr Hunsworth as supporting a case of de facto trustee or constructive trust of the first category, there is nothing to show that at the time of receiving the dividends issued by SHH or the plaintiff, the defendants intended to act as trustees over the dividends and/or had assumed the obligations of a trustee vis-à-vis the plaintiff.  The fact that the 1^st defendant is the trustee of the Trust and had, in that capacity, received trust assets from Dr Mong is an irrelevant consideration both because the plaintiff is not a beneficiary under the Trust and also because it is clear from the pleading that the plaintiff’s claim is not premised upon the 1^st defendant being the trustee of the Trust.

26.  Thirdly, on the plaintiff’s case, the 2^nd defendant has no entitlement to the dividends issued by SHH and the plaintiff.  The receipt of the dividends in the form of the three promissory notes is therefore wrongful.  It is therefore not a lawful transaction independent of and preceding the breach of trust and one which is not impeached by the plaintiff, an element that characterizes the first category of trust and trustee: see Paragon Finance v. D B Thakerar & Co, supra, 408j-409a.  On the contrary, the receipt of the dividends and promissory notes is at all times wrongful and adverse to the rights of the plaintiff, a feature that characterizes the second category of constructive trusts: see Lord Sumption’s judgment in Williams v. Central Bank of Nigeria, supra, §31. 

27.  Fourthly, even on the case advanced in Mr Hunsworth’s submissions, knowledge remains an integral element of the plaintiff’s claim against the defendants, namely, the defendants came into possession of the dividends and used them to acquire the interest in SHH with knowledge that this was unauthorised by the shareholders of SHH or the plaintiff and/or a breach of Dr Mong’s fiduciary duties.  Any trust obligations assumed by the defendants will therefore be the direct consequence of the transaction complained of by the plaintiff.    

28.  For these reasons, I do not accept that it is arguable that the defendants are constructive trustees of the first category, whether as de facto trustees or trustees de son tort.  On the contrary, it is clear from the statement of claim, especially at §§33 and 34, that the plaintiff claims against the defendants as constructive trustees on the basis that they are knowing recipients.  The plaintiff’s claim does not come within section 20(1)(b) of the Limitation Ordinance and is therefore time-barred.  It also follows that the defendants have succeeded in showing there is no serious issue to be tried, such that the order granting leave to serve the concurrent amended writ of summons on the defendants outside jurisdiction should be set aside.

Disposition

29.  Accordingly, I would allow the defendants’ appeal and set aside the order of the Master granting leave to serve the concurrent amended writ of summons on the defendants outside jurisdiction.  I would also make an order nisi that the plaintiff pays the defendants the costs of this appeal and below, to be taxed if not agreed.

[1] The equivalent of section 20(1) of the Limitation Ordinance.